Schlumberger’s got some explaining to do on Smith

February 23, 2010

Schlumberger’s shareholders have been freaking out since news leaked last week of the company’s bid for oil field services rival Smith International. Skeptical investors have now stripped almost $7 billion from the value of the industry leader — a powerful slap in the face to Schlumberger’s chief Andrew Gould. Such punishment appears excessive.

True, Gould hasn’t secured a steal. By Schlumberger’s own account, cost savings from Smith will be just $320 million a year by 2012. Taxed and capitalized, these would be worth around $2 billion to shareholders. So, by offering a $3 billion premium, at $45.84 a share, Schlumberger looks to be destroying around $1 billion of value.

But Schlumberger’s tumble suggests that investors fear Smith may prove an even bigger liability. The deal may indeed tie up precious management time as the anti-trust process grinds forward. Baker Hughes is still kicking its heels while regulators vet the purchase of BJ Services, which it announced in August.

Apart from these anxieties, however, the deal has some powerful strategic logic on its side. It is hard to see a financial exploding gun in Smith’s balance sheet. The company’s $1.2 billion of debt is small potatoes for Schlumberger, which has cash and short term investments of $4.6 billion.

Moreover, the absence of a significant drill-maker in Schlumberger’s product line is becoming an embarrassing omission. This is Smith’s forte. Recent oil finds are forcing companies to drill ever deeper for oil — 11 km (more than six miles) down in the case of BP’s giant find in the Gulf of Mexico. Complex shale gas operations are demanding ever more sophisticated drilling technology.

As extracting oil and gas becomes ever tougher, making sure that tools work perfectly together is becoming crucial. Gould has his sights set on a new generation of drilling technology. Meanwhile, giant state-run oil companies are increasingly demanding a full-service option.

Even if the deal fails to deliver a boost to revenue once the companies combine, it’s hard to see how it can hurt them. Shareholders’ lack of faith in Gould is unfair. But he has his work cut out to dispel investor doubts.

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The muchstardude is a cut and paste comment I’ve seen on several blogs here. Probably a bot. Delete it.

==Bob D.

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